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Thursday, May 12, 2016

Living Beyond Your Means - What it Means

Living beyond your means doesn't just mean accumulating debt, it also means you are time-shifting money by failing to save or spending your savings too fast.

When I was a kid, my Mother would use the phrase "living beyond your means" as in "the Jones' are putting on the dog, but they are living beyond their means." I didn't really understand what this meant until later life when I was living beyond my means by accumulating debt. But I realize today that living beyond your means is something than anyone can do, and in fact, most Americans are doing today.

As I noted in an earlier posting, the phrase at first makes no sense. To the uninitiated, how can you live beyond your means? It is physically impossible! You can't buy more stuff than you have money for, right? Well, wrong on a number of levels.

There are multiple ways you can "live beyond your means" as it turns out:

1. You can accumulate more and more debt, particularly credit card debt, over time, and eventually end up bankrupt. This process could take decades, however, particularly if you "cash out" your house using a home equity loan or refinancing.

2. You could fail to save for retirement, which is an obligation you have to society. Again, you won't see the effects of this for decades, when you retire and realize you are a pauper.

3. You fail to save for "emergencies" (which are actually contingencies) such as car repairs, health issues, home repairs, and other unexpected (but expected) expenses. Again, you may not feel the effects of this for years, even decades, until you are blindsided by such an expense and then have to resort to toxic debt arrangements.

4. You spend more than you should in retirement and run out of money before you die. Again, you may think things are going well but two decades later, you realize too late that you shouldn't have bought that shiny new motorhome or fancy boat.

All of these things involve spending more money than you should and it is not hard to figure out how much you should be spending. Well, it is hard and tedious, but if you want to be really happy in life, it is a good idea to work out a budget and think about money instead of spending it willy-nilly.

When the Titanic struck an iceberg, it took well over an hour for the ship to sink. Right after the fatal collision, not much seemed different aboard ship, other than the engines stopped and people had snowball fights on the foredeck. The ship can't be sinking, right? Everything is going so well! More champagne, anyone?

Similarly, if you are at 30,000 feet and lose an engine on your airplane, you might go on for hours, slowly losing altitude. If you can find an airport before you run out of altitude, you'll be fine. If not, you are going to crash. But again, things may seem "swell" initially and nothing really seems that critical for the moment.

The same is true in finances. If you are living beyond your means, things don't seem dire, in fact they seem pretty swell! The day you drive home from the dealer with that new Camaro, you feel pretty fine - you have a brand-new car in your driveway! But you haven't made the first payment on it yet, and you haven't paid the onerous insurance bill (which will be onerous once you get that first speeding ticket).

The first situation (credit card debt) I described in my previous posting. This is the first and most fundamental trap people fall into - and I fell into it myself. You use those nice plastic cards for everything, not thinking about when the payments are due, how much is due, or what the interest rates are. Typical kid stuff - but many play this game well into their 30's and 40's. Credit card balances edge up and it becomes harder and harder to pay off the balance and a home equity loan or home refinance seems like a swell way to lower your monthly payments and pay off the balance (with declining interest rates in the 1990's and 2000's, this often meant a lower monthly mortgage payment and paying off the balance on the cards. But this also meant an increasing balance on the mortgage plus lots of junk fees tacked on. Your net worth was actually decreasing even if your cash-flow was better).

The problem is, of course, that the banks "reward" you by increasing your credit card limits and enticing you further to spend. And if you didn't learn the lesson the first time around, you might come back for a second or third spanking until the bank won't loan you anymore money on your house.

And when housing prices went down in 2008, well, we all know how that worked out.

The second scenario (failing to save for retirement) is one being played out today across the country. America's retirement crises. The 401(k) generation was supposed to save up money for retirement rather than receive a pension. Given how insolvent pension plans are, this is not a bad idea, but it does require discipline on the part of the citizen.

The problem is, people claim to be living "paycheck to paycheck" and thus claim they cannot save. They can, however, buy beer and pot, visit the tattoo parlor, and watch 500 channels of cable TV - while texting about what a raw deal they got in life on their new smart phone. Rich or poor, upper middle-class or lower middle-class, people blow enormous sums of money on utter crap, while failing to save one dollar for retirement. In the suburbs, it is buying a monster truck, in the ghetto it is renting-to-own a set of bling rims for a $1500 Chevy.

So we see an enormous amount of people staggering toward retirement age with nothing saved whatsoever. They chant, "I'll just work until I'm 70!" but fail to realize the company they work for likely won't let them do that. So they will have to take on a second career, likely for far less money, and then struggle in old age and live in penury, with only fading tattoos and memories to support them.

The third scenario (failing to save for emergencies) is also quite common and I suspect a majority of Americans are in this boat. Payday loan places thrive on people's inability to budget not just for immediate needs, but future ones. For example, you are living "paycheck to paycheck" but manage to buy a monster truck and put an horrifically ugly set of 22" chrome rims and noisy knobby tires on it. This is typical of lower-middle-class and poor folks in the area where I live. Thousands of dollars spent making a truck into a vehicle that is basically no good for hauling things, which is what trucks are for. And of course, the owner doesn't "need" a truck so much as they want to look tough and impress their friends.

So the truck breaks down and needs repair. They can't pay for the repair because their credit is crap and their credit cards are maxed out. But they have to get to work! So they go to the payday loan place and borrow $300 which quickly becomes $450 when they can't pay off the balance next week (God forbid you should go without pot or beer for a week, right?) And pretty soon they are in Payday loan hell, never able to pay off the balance. So they get a title pawn loan to pay off the payday loan, and eventually, they lose the truck and their job and go bankrupt.

But, for a few months, years, or even a decade of "paycheck to paycheck" spending, nothing appears to be wrong. After all, they got a bitchin' truck with bling rims and killer tats and the cooler is always full of beer, right?

And lest you accuse me of being elitist, let me remind you that I lived this lifestyle myself and had dozens of friends who lived it. It is not elitist to simply report the truth. And the truth it is.

The last scenario (overspending in retirement) is something of a novelty for most Americans, who were born and raised in the pension world. The lovely thing about pensions - until recently - was that you could retire to Florida, buy a house, and go fishing and golfing every day and not worry about money because the company pension plan plus Social Security would provide X dollars every month, and so long as you spent less than that, you were golden.

Today, pension plans are fast disappearing and a lot of us have to retire on savings plus Social Security. Living on Social Security alone is a bleak prospect for most people. And if you burn through your savings early in retirement by living large and having fun, you will be destitute at a time in life when you need money the most and are least likely to find any kind of employment to supplement your income.

Living here on retirement island I saw this last scenario play out and it scared the shit out of me. And it can indeed happen to people with nice pension plans. In two instances, this involved large purchases of motorhomes. For one couple, the motorhome lifestyle was fun for a few years, but they made the mistake of "trading up" to impress the people in the RV park. When illness came, they were upside-down on the "coach" and had to walk away from the deal with their credit rating in ruins and absolutely no money in the bank whatsoever.

Another couple had a good pension and Social Security and thought they could "afford" a high-end coach based on the monthly payments. But since these things are financed over a decade or more and they depreciate rather rapidly, they too found themselves "upside-down" on the coach to the tune of $60,000 which as pensioners, they did not have. So after selling the coach, they now find themselves having to pay off a debt from their pension income stream for a number of years to come.

The net effect of all these scenarios is time-shifting money which is really all debt is. In some instances it is easy to see the effects - your debt load increases over time. In others, it is a little more subtle, as your net worth is decreasing over time. And often it is hard to fathom these things because you think you are doing well at the time, paying all your bills, while this cancer of time-shifted money eats away at you, unseen.

Monitoring your monthly cash-flow is one immediate way to tell if you are in trouble. If more is going out than coming in, you likely have a problem. Monitoring your debt load is also useful, as if it is increasing over time, you likely are living beyond your means. Monitoring your net worth is one way to tell if you are heading downhill. As part of a set of Financial Gauges, it tells you whether you are climbing or descending.

But in retirement, all three of these gauges might not work for you. If you are retired on the proceeds of your 401(k), your monthly cash-flow will always be negative. Your debt load should be zero, so that indicator is basically of no use (if you are borrowing money and paying it back with savings, it makes little sense). And your net worth will decline over time as you get older. But like the crippled airliner scenario, you have to hope to find an airport and "land" before you run out of altitude or fuel.

And in retirement this means you have to hope your money lasts as long as you live, so you don't run out before you die (cheerful thought) but on the other hand, don't leave any money on the table for ungrateful heirs.

So how do you live within your means? It isn't easy. One way is to go to an all-cash lifestyle. You can't accumulate credit card debt if you don't have credit cards! The credit card industry would rather you didn't do this, of course, so they entice us with cash-back-rebates and other come-ons. They throw pennies at us, hoping we spend dollars. And I am not the only one to fall into this credit card trap. As I noted before, most Americans will have a credit card crises in their lives. Those of you who haven't had one are like the motorcycle rider who hasn't had a wreck. Just wait for it.

But an all-cash lifestyle is very inconvenient these days and the only folks who practice it are either forced to, or are doing so to make a point. I am not against this idea, of course - we are all weak and relying on "willpower" to keep you out of trouble is not a very good plan. For most folks (like the couple in the link above) things become a race to the bottom of spending, and before long, you have $100,000 in credit card debt (in their case) and no real means to pay it off.

Another alternative requires setting up a budget and sticking to it. Once you start budgeting your money, you realize exactly how poor you are even if you are making six figures. The couple in the link above were lucky in that they were able to communicate with each other and agree on a plan of action and make sacrifices for their own future. Many couples can't do this and opt for divorce (which is even more expensive!) rather than sacrifice. Too late they find out they screwed each other royally.

Getting into the poverty mindset is helpful. Stop thinking you have a lot of money just because you have a lot of money. I see people saying they are "well off" because they have $200,000 in the bank. Really? You have enough money in the bank to live for four years on the median income in America and that is rich? How would that even begin to fund retirement?

In my next posting, I will get into our budget and some of the alarming spending habits we have fallen into in the last few years. And it is not hard to do, a dollar here, a dollar there, before you are heavily into debt. While it seems that "everyone" spends money that way, the reality is, most of those folks don't spend money that way, or are living beyond their means and headed for a world of woe down the road. Using the spending habits of other people as a normative cue is a really, really poor idea. It is how we end up living beyond our means in many cases.